Types of taxes and tax systems: classification, principles and basic concepts

The government raises the levy on tobacco, and sellers raise their prices by the full amount. Buyers carry on buying. Who has paid the tax? On whom did it fall first, who bears it in the end, and what happened to sales? One short scenario uses most of the vocabulary the exam tests: tax base, tax yield, tax rate, incidence, burden, impact, shift and effect.

The same topic asks you to classify taxes three ways (by the subject, by the base and by the way the burden is spread) and to list the qualities of a good tax system.

This topic covers the Nigerian tax system, the principles of a good tax system, the classification of taxes, direct and indirect taxes with their merits and demerits, proportional, progressive and regressive taxes, the difference between taxes and levies, and the basic concepts of taxation. The previous topic covered what tax is and its objectives. The next covers the sources of tax law.

Key terms in plain English

Syllabus check

This topic is in syllabus area A, introduction to taxation, tax administration and ethics (20% of marks). It covers:

• the Nigerian tax system and the principles of a good one;
• classification of taxes and the differences between taxes and levies;
• basic concepts in taxation.

CAMA 2020 and the tax system

The Companies and Allied Matters Act 2020 (CAMA 2020) is the company law of Nigeria. The sections below apply to this topic.

The rules in more depth

The Nigerian tax system

A tax system has three parts: the policy, the tax laws and the tax administration.

• Tax policy is a set of general statements of intention that guide the thinking and action of everyone concerned towards the set goals. It includes moving the emphasis from income tax to consumption tax, which is less prone to evasion; reducing individual tax burdens, widening the tax net and encouraging savings and investment; introducing self-assessment to bring taxpayers into the assessment process; and moving from coercion towards voluntary compliance.
• Tax laws include the Personal Income Tax Act, the Companies Income Tax Act, the Capital Gains Tax Act, the Value Added Tax Act, the Tertiary Education Trust Fund Act, the Stamp Duties Act and the Petroleum Industry Act 2021 (all for periods before 2026). The Constitution gives the legislation of income tax, personal or corporate, to the Federal Government to promote uniformity, but the administration is shared by the three tiers of government. Laws are reviewed to match social, political and economic change, and non-compliance attracts penalties.
• Tax administration is the practical interpretation and application of the laws, by the Federal, State and Local Governments. The FIRS Board, the State Boards of Internal Revenue and the Local Government Revenue Committees are set up under federal laws.

A good tax system should create jobs and a tax increase should lead to the arrest of wasteful spending. No one pays tax with a smile, but tax makes the private sector pay for services given by the public sector. It shapes and directs economic activity, redistributes resources and finances social welfare. A “tax cut” does not mean government gives something back.

It means government takes less of people’s money, so that they can spend more of it as they choose.

Principles of a good tax system

Classification of taxes

Taxes can be classified from the perspective of the tax subject, the tax base or the distribution of the burden.

By the subject: direct and indirect. A direct tax is levied directly on the taxpayer’s income, for example company income tax, PAYE and capital gains tax. An indirect tax is levied on goods and services. It may be specific, a fixed amount per unit, or ad valorem, a percentage of the cost. Examples are import and export duties, excise duties and VAT.

By the base. The base may be capital (capital gains tax), income (personal income tax and company income tax) or consumption (VAT and excise duties).

By the distribution of the burden.

• Proportional: the same percentage of income, such as company income tax and capital gains tax.
• Progressive: the more the taxpayer earns, the more he pays, such as PAYE.
• Regressive: the person with a smaller income pays a greater percentage than one with a higher income. All flat rates are regressive in effect, and VAT is the example.

Taxes and levies

Nightingale (1997) describes tax as a compulsory contribution imposed by government, for which taxpayers may get nothing identifiable in return, though they benefit from living in a relatively educated, healthy and safe society. Tax is not charged for a specific service.

Levies are paid for specific services, as with a fee such as a court fee, which covers the cost of a service done mainly in the public interest but giving the payer a special advantage. Fines and penalties are another form of levy: they punish breaches of law and do not raise revenue. All taxes are levies, since they are imposed, but not all levies are taxes.

The tax on company profits in section 9(1) of the Companies Income Tax Act is a tax, while the penalty and fine in section 85(1) are only a levy. A tax, like a levy, is compulsory, but it is not meant to punish. A tax must be backed by a written law, and if a law is invalid then a charge made under it cannot be a tax.

If a charge rests on a valid tax law, it is a tax whatever it is called.

Basic concepts in taxation

The position from 2026

The concepts and classifications do not change. For periods from 2026 the laws are the Nigeria Tax Act 2025 and the Nigeria Tax Administration Act 2025, and the tax authority is the Nigeria Revenue Service. The Nigeria Tax Act reduces the number of levies by replacing several with the 4% development levy, which fits the policy aim of fewer, broader taxes.

Worked examples

1. PAYE: direct, income base, progressive.
2. VAT: indirect, consumption base, regressive in effect.
3. Capital gains tax: direct, capital base, proportional.
4. Excise duty: indirect, consumption base.

1. The producer collects and pays the tax.
2. The incidence falls wholly on the buyers, because the price rose by the full tax and demand did not change.
3. The impact on consumption is nil in this case.

1. First person.
   5,000 ÷ 50,000 = 10% of income.
2. Second person.
   5,000 ÷ 500,000 = 1% of income.
3. The smaller earner pays a larger share, so the tax is regressive.

How to score full marks

• Give a one-line definition and an example for each concept.
• Set out merits and demerits of direct and indirect taxes in two columns.
• List the seven principles with a phrase each.
• Link tax to levy by the rule that every tax is a levy but not every levy is a tax.

Common mistakes in the exam

• Mixing impact and incidence: impact is the effect on output or consumption, incidence is who bears the burden.
• Calling VAT progressive.
• Giving only merits, or only demerits.
• Omitting the two kinds of equity.

Quick revision

• Seven principles: certainty, economy, convenience, efficiency, equity, flexibility, neutrality.
• Direct: income and capital. Indirect: goods and services.
• Proportional, progressive, regressive.
• Concepts: base, yield, rate, incidence, burden, impact, shift, effect.

Practice questions

Questions 1 to 10 are multiple choice. Questions 11 to 13 are written. Try each before opening the answer.

Model answers

Spotted a mistake? Tell us and we will check it.